Surf Air responds as Encompass Aviation sues citing $3.1 million in unpaid bills

Encompass Aviation says Surf Air owes it $3.1 million on top of the IRS’s claims of nearly $2.5 million

As we reported here first in the wee hours of Saturday morning – just after midnight – we received a press release from Surf Air announcing it had terminated its agreement with Encompass Aviation LLC. The news took Encompass by surprise, and we reported that the Part 135 charter operator that had been flying Surf Air customers in California claimed it was owed significant money and planned to pursue legal remedies. Yesterday Encompass Aviation LLC filed a lawsuit against what it described as “financially distressed membership based charter broker Surf Air.” It is seeking $3.1 million to cover money that the Surf Air allegedly owes. The legal action came after Private Jet Card Comparisons revealed that in May the IRS had issued to tax liens against Surf Air totaling nearly $2.5 million. The liens appeared related to unpaid Federal Excise Tax.

After more than three days without a response (at least to us), Surf Air CEO Sudhin Shahani issued the following statement yesterday to Bloomberg, stating, “Surf Air terminated its agreement with Encompass on Friday for breach, citing various reasons including performance issues. We believe their suit has no merit and intend to defend ourselves vigorously, while seeking any and all remedies available to us.”

On Monday, when asked to comment about the IRS liens, he told Aviation International News, “This matter is under review and we cannot comment at this time.” Just off the phone with Sudhani, he now says the company does, in fact, owe money to the IRS and is working out a payment plan which he described as “active and cooperative.”

Encompass said in its lawsuit it had been acting as primary California operator since May 2017. Surf Air never formally announced it was transferring operations at that point, and that transfer was only revealed by AIN in a November report. In the release from Encompass, it alleged, “Because of pending federal government investigations concerning Surf’s possible illegal activities in 2016, Surf and its board decided that selling its airline assets to a U.S. entity would significantly broaden their opportunity to expand and to make its product offering more attractive to its membership base. Resulting negotiations led to an agreement in May of 2017 for Encompass, at the time a fully FAA-certificated air operator, to acquire Surf’s airline assets and operate for Surf in California.” Sudhani tells us the decision to outsource to Encompass was based on a business decision to use third-party operators instead of operating its own aircraft and there was no reason behind not announcing it at the time.

The lawsuit by Encompass, filed in the United States District Court for the Southern District of New York, asks the court to enforce Surf Air’s obligations to Encompass as specified in several operating agreements signed by the two companies last year, and also to enforce subsequent payment agreements stipulated to in the interim. As of June 14, 2018, Surf Air owed Encompass more than $3.1 million, while engaging other operators in an attempt to keep flying while defaulting on their agreements with Encompass, according to the press release issued by Encompass.

“We have been happy to serve as Surf’s primary carrier in the state of California. But we’ve come to the breaking point. Surf has repeatedly allocated its revenue on things other than paying in full for flight operations and aircraft maintenance,” said Steve Harfst, President and CEO of Encompass Aviation. “Surf has failed to honor its obligations under its agreements with Encompass and we have been significantly damaged as a result, both by Surf’s repeated failure to pay for services rendered and by its blatantly improper attempt to walk away from our service in favor of another operator.”

He said, “Within a short time (of it taking over flights in California), Surf failed to make its agreed-upon payments to Encompass. Just four short months into the contract, Surf’s payment deficit had ballooned to more than $3.7 million. Despite non-payment, Encompass continued in good faith to operate flights and maintain the operating integrity and safety of the aircraft used to transport Surf’s customers.”

The Encompass release continued, “Throughout the term of the agreement, Surf continued to demand performance by Encompass in exchange for little to no payment. Despite collecting revenue from its members, Surf failed to pay the contracted costs for flight operations and related maintenance responsibilities undertaken by Encompass.”

Encompass concluded, “On June 15, 2018, without any prior notice, Surf sent a termination letter to Encompass after it granted another operator the right to operate all Surf Air flights in California. This is in violation of the right of first refusal clause of the contract between Surf and Encompass. In addition to today’s legal action, on Monday, attorneys for Encompass sent a cease and desist letter to Surf Air’s board of directors and management, seeking payment owed and to prevent them from taking further action against Encompass.”

Statement from Sudhin Shahani, CEO of Surf Air

As we were about to publish this article, we heard back from Shahani via email, including the below statement as a response to Encompass lawsuit:

“Since the early stages of the parties’ commercial relationship, which started in May 2017, Surf Air’s business was faced with, among other things, Encompass’ unreliable and substandard service quality and overall poor management of the flight operations and Surf Air relationship. These issues were disclosed to and discussed with Encompass on a regular basis. However, after one year of operations, there was no improvement, all of which had led to a reduction in flight hours, loss of revenues, sizable and questionable cost overruns, and an untenable situation for Surf Air.

“To add further to the significant problems resulting from its association with Encompass, Surf Air learned that Encompass was attempting to interfere with Surf Air’s relationships with its financial partners, a clear breach of trust. With the combination of poor performance and bad faith actions, Surf Air took action and terminated its relationship with Encompass for default.

“In connection with the termination of its agreement with Encompass, Surf Air is disputing amounts that Encompass claims are unpaid and is demanding that Encompass return the eight Pilatus aircraft that were subleased to Encompass by Surf Air to provide flight services to Surf Air. For amounts in dispute, Surf Air has requested that Encompass provide supporting information to allow Surf Air to confirm and reconcile costs. Surf Air also intends to pursue damages and exercise all other rights and remedies it has against Encompass for its breach of its agreements with Surf Air.”

We then talked to the CEO by phone. Shahani says problems with Encompass were related to flight completions and canceled flights, and that he was not concerned with the safety of flights Encompass was operating and transporting Surf Air customers. Asked why it took over a year to terminate the agreement when there were problems from the start, he says, “There’s never a good time, but it had become untenable.”

After Surf Air acquired RISE, a similar all-you-can-fly membership operator in Texas, it has since outsourced its flying to Tradewind Aviation, which Sudhani today says continues to operate its flying in Texas. An extensive route expansion outlined at the time of the acquisition, however, never materialized. Similarly, Surf Air in 2017 launched in Europe, also with its own aircraft, but contracted operations to a third party from the start. It had promised expansion with its own fleet of Embraer Phenom 300 and Pilatus PC-12 aircraft using third-party operators. Early this year, it was selling potential members in Europe with the promise of new routes forgetting to mention it was changing its model and the future flights would be an agreement to buy seats via JetClass, itself a charter operator that sells the same seats on scheduled private jet flights – without a membership fee.

Over the weekend, Levi Stockton, president and chief pilot of Advanced Air, which assumed operations for Surf Air in California, told us his company was prepared to fly Surf Air’s scheduled flights without interruption.

Over the past year, the private aviation segment has seen the Chapter 7 bankruptcy of Zetta Jet, which was operating long-range luxury-laden jets and the shutdown of ImagineAir, which sold jet card memberships for short hops on a fleet of single-engine Cirrus SR22 single-engine props. Earlier this month, JetSmarter announced it was changing its model allowing non-members to book and start shared charters with the sharing economy by-the-seat private jet play. At about the same time ZED Aerospace said it planned to launch Aura in 2018, which would include private jet size aircraft in a luxury configuration flying between private jet terminals but charging by the seat fares closer to commercial flights. All the news comes as private aviation travel continue a strong rebound in the charter and jet card markets.

I am Founder and Editor of Private Jet Card Comparisons, the only independent buyer's guide to jet card membership programs, and DG Amazing Experiences, a weekly luxury travel e-newsletter for private jet owners. I am also a contributor to Forbes.com